Global Risks Are Mounting

Morgan Stanley ^ | Jun 21, 2002 | Stephen Roach

[Gritty]

Suddenly, the world is tipping again. Geopolitical tensions remain at the boiling point, and recovery in the global economy looks shaky, at best. Meanwhile, financial markets are seizing up in the industrial world, and crisis is the only word to describe conditions in Brazil that are rapidly spreading to other Latin currencies. All this is starting to seem reminiscent of the dark days of late 1998 and early 1999. Yet there’s one key difference: America is not in any position to save the day by administering the tonic of global healing that worked so well three years ago. That puts the global outlook in an exceedingly difficult light.

The news flow on the state of the global economy is simply terrible these days. US consumption growth seems to have sagged through the critical 2% threshold in 2Q02 -- underscoring the distinct possibility that the over-extended American consumer may simply be incapable of carrying the global economy for much longer. French consumer spending plunged in May and Italian business confidence sagged appreciably in June. I am just back from nine days in Europe and I can assure you there’s nothing vibrant in Euroland these days -- work stoppages are mounting by the day and intra-EMU squabbling is on the rise. Nor are there any signs in Japan that that the 1Q02 growth pop is sustainable; a 1.5% plunge in its service economy in April (the so-called tertiary index) is painfully consistent with the caution that our Japan team has long expressed on the state of the real economy.

Non-Japan Asia is also showing signs of running out of steam. Courtesy of a powerful US inventory dynamic, the region got off to a solid start early this year. But sustainable recovery in this still externally-led region needs more than just a US inventory cycle. The lack of follow-through on the final demand front remains especially worrisome in that regard. The recent cuts we have made in our global trade forecast for 2002-03 underscore those very concerns (see my 21 June Global Economic Forum dispatch, "Lowering Our Sights on Global Trade"). Korea stands largely alone in Asia in shifting its growth dynamic to domestic demand -- although Daniel Lian has stressed similar efforts are under way in Thailand. But as Andy Xie, has argued, Korea’s consumption boom may well have backfired. Household debt has exploded by 33% over the past year and a bubble has emerged in the Seoul property market; at the same time, the Korean trade account swung into deficit in the first 20 days of June -- capping off a long erosion from the 12.7% surplus (as a share of Korean GDP) in 1998. In response, the central bank of Korea has begun to tighten ahead of this fall’s elections -- raising the distinct possibility that the country’s experiment with consumer-led growth is nearing an end. Moreover, borrowing a page out of the script of the early 1990s, trade conditions have also deteriorated elsewhere in Asia -- especially in the Philippines, Thailand, and even Singapore.

And so, once again, it all hinges on the ability of the once-proud American growth engine to save the world. That could turn out to be the biggest disappointment of all. That’s because the United States now has the "mother of all" current account deficit problems -- an external imbalance that will inhibit America’s ability to fuel global recovery of a still US-centric world. The just-released 1Q02 US current account data underscores this dilemma. The $112.5 billion deficit -- or $1.25 billion per day -- amounted to 4.3% of US GDP. That’s slightly worse than implied by our baseline forecast (4.2%) and well on a path to pierce the all-important (i.e., ominous) 5% threshold by year-end 2002. At the same time, I note with interest a May US budget deficit of $81 billion, literally three times the shortfall of a year ago. Gone are the days when Federal saving would offset the lack of saving in the private economy. America is as saving short as ever --little wonder it needs foreign capital inflows to fund it. If anything, that suggest pressures on an ever-expanding current-account deficit can only intensify in the months and quarters ahead -- that is, unless the US finally starts to rein in the excesses of its own domestic demand.

Therein lies the dilemma for the world. Back in the crisis days of late 1998, America’s current-account deficit was "only" 2.7% of GDP. While most of us thought that was high at the time, in retrospect, there was considerable scope for further expansion as the US stepped up and led the world into a glorious recovery that we dubbed "global healing." That’s right, it wasn’t all that long ago, that we were the out-of-consensus bulls on the global economy. But now the tables have turned. The global healing of 1999 saw America’s current account deficit expand by two full percentage points of GDP over the subsequent two years, hitting an all-time record of 4.6% in the year 2000. A two-percentage point widening from today’s level would push the external imbalance up to 6% of GDP -- requiring financing via capital inflows of close the $2 billion per day.

I am not saying that can’t and won’t happen. But it is ludicrous, in my view, to ignore the obvious and important consequences of a sharp further widening of America’s gaping current account deficit -- should it occur. The once-high-flying dollar will bear the brunt of such an imbalance, and that realization now seems to have sunk in with a vengeance in foreign exchange markets. But other US asset markets could also be affected -- a possibility that is hardly being lost on the beleaguered US stock market. But the weakness of the dollar puts the world on notice that the old days of US-centric growth are over. The flip side of that outcome is that the euro- and yen-blocs are going to have to learn to live with stronger currencies. And with these still externally-dependent regions lacking in domestic demand, their life is about to get considerably more difficult. That’s a far cry from the magnanimous climate of global healing of three years ago. This time, as the outbreak of global trade tensions also seems to indicate, it’s every country for itself!

It’s crunch time for the old recipe of US-centric global growth. What worked so brilliantly for the past seven years seems unlikely to do the trick this time. Global risks are mounting and there may be no easy way out for world financial markets.

[Gritty]

Ping!

[sarcasm]

ping

[Barbara14]

"Yes, we need a global king with super natural powers who can bring everything into alignment. We need a king, not just a president because global problems are greater than any president. We need a king who is far above the norm, yet very capable at communicating with the masses. Send us this king who will take care of us and think of us as his little children. Let him have white hair and a sweet smile. We need a king.".....and you're going to get one soon..

[razorback-bert]

, Korea’s consumption boom ...a bubble has emerged in the Seoul property market

Notice other economies suffer bubbles, but not the US.

[DeaconBenjamin]

Did y'all see Germany's tottering banks at http://www.freerepublic.com/fo cus/news/703379/posts?

[Gritty]

No, I didn't see it. Thanks for the link.

America is not the only country going into The Tank. There's lots of company out there, if that is any consolation.

[rohry]

I'm not flaming you here but could you tell me what you are talking about? Also, please tell me where the quote is from? I did not notice it in the article.

[rohry]

Since the end of WWII the US has bought goods from, sent aid to and paid for the defense of countries around the world as they drifted further left. Despite our own creeping socialism/fascism we are still the locomotive of the world economy. If we don't buy Mercedes and Porsches from Germany, wine and cheese from France and consumer electronics and autos from Asia then their economies go into the tank because their consumers are so hindered by regulations that they don't really have a free market.

When our economy starts to have problems (I think we have a double-dip recession coming-if not worse) these dependent economies will start to run up on the rocks and self-destruct. In the 1930's depression Great Britain was still a very strong capitalist economic power and they didn't suffer much from the downturn (partly because of compliant colonies). In the year 2002 no economy can survive without US consumers buying foreign goods with one of their 15 credit cards or the 2nd mortgage they just negotiated with funny money from the Fed.

My point? There is a big change coming here and the excesses of the welfare economies and PC laws will be exposed as Daddy Warbucks (that is us guys) cut back their purchases from foreign countries as the dollar loses value and markets grind lower and lower.

[sarcasm]

Economic parallels between America and Japan

Terrible twins?

Jun 13th 2002
From The Economist print edition

America's economy looks awfully like Japan's after its bubble burst

JAPAN'S economy rebounded at an annual rate of 5.7% in the first quarter of this year, a shade faster than America's. Unfortunately, many economists distrust Japan's notoriously volatile statistics: they expect output to fall again in the current quarter. More than 12 years since Japan's stockmarket bubble burst in December 1989, its economy remains fragile. Meanwhile, America appears to have survived the bursting of its bubble in 2000 rather better—so far.

The similarities between America's financial bubble in the 1990s and Japan's in the 1980s have been well rehearsed. In both cases, share prices and capital spending soared; households and companies went on a borrowing binge. Japan, like America a decade later, enjoyed a spurt in productivity growth, suggesting to some that it had a superior economic model.

Yet the conventional wisdom now is that the economies have taken divergent paths since their bubbles burst. Thanks to resilient consumer spending, America is widely tipped to enjoy robust growth this year and next. Meanwhile, Japan is expected to languish in perpetual recession.

Look again. America's economy over the past two years has in many ways mirrored the performance of Japan's immediately after its bubble burst (see charts). In the two years from December 1989, Japan's stockmarket fell by 40%, slightly more than the 33% fall in the S&P 500. Japan's economy held up well during those two years. GDP growth did not turn negative until 1992. Capital spending slowed sharply, but consumer spending continued to boom. In fact, property prices continued to rise strongly for two years after the stockmarket tumbled. This sounds like America today, since rising house prices have bolstered consumer spending.

Economists argue that recent swift productivity growth points to robust recovery in America. Yet productivity growth in Japan was almost as brisk in 1990-91. America's troubles may still lie ahead.

Another claim is that America's Federal Reserve has eased interest rates aggressively, whereas the Bank of Japan was slow to ease and so failed to prevent deflation. The Bank of Japan has been overly cautious in recent years; but criticism of the bank's policy in the early 1990s may be unfair. Deflation did not develop until the mid-1990s. In 1990-91, Japan had a higher inflation rate than America has today.

Admittedly, Japan did not start to cut interest rates until 18 months after the stockmarket began to fall, whereas the Fed started only nine months after. Yet if monetary policies are considered in relation to growth rates, it is not clear that interest rates were cut more swiftly in America. As the lower chart shows, GDP growth was brisker in the early 1990s in Japan than it was in America last year. According to Stephen King, chief economist at HSBC, both the Bank of Japan and the Fed began to cut interest rates during the third consecutive quarter of below-trend growth.

And what about one other popular argument in support of America's economic resilience? Japanese firms in the late 1980s used shady accounting practices to conceal financial problems. Now that could never happen in America.

[rohry]

Good post. I have seen this comparison between the Japanese economy and the US economy before and think that it is close to what will happen. The difference is that the Jap economy is an export driven one and ours is consumer based. Everyone depends on the US to purchase their goods. If our purchasing dries up then the export economies around the world suffer.

By the way, I got trashed on another thread for posting this chart by discotou:

[Ken H]

Good read here.

[walden]

And some more.

[sarcasm]

Bush will probably emulate the Japanese by taking the political expedient, but ultimately disastrous, step of borrowing and throwing money at the problem. I wonder when we will start hearing calls for spending on infrastructure as happened in Japan.

[B4Ranch]

"All truth goes through three stages.
First it is ridiculed.
Then it is violently opposed.
Finally, it is accepted as self-evident."
(Schopenhauer)

What stage are we in now?

[B4Ranch]

The only thing worse than telling the truth is showing it to those who will not listen.

[B4Ranch]

Have they restricted withdrawls yet?

[DeaconBenjamin]

I haven't found an answer to your question, but apparently some bank workers are on strike in Germany (they are unionized).

[B4Ranch]

Thank you for trying.

[avenir]

"Global Risks Are Mounting"

Good! I'm ready to go be with Jesus. Bring it on!